When governments cannot raise enough money from taxes to pay for their various schemes, they borrow it on local or international markets. Thus the fascinating question for foreign lenders: will this government pay back the money it has borrowed?
In principle, no problem. Governments might be expected to behave decently (defaulting on debt besmirches national honour). Plus governments can to raise taxes or inflate the currency and somehow find the money needed to keep foreign creditors happy.
However, down the ages, all sorts of ingenious excuses have been used by governments to avoid fulfilling their responsibilities, and defaults have taken place. Defaults come with a cost. Lenders lick their wounds and for a while are cautious about lending to that country again.
As large sums of money are involved, fiendishly complicated rules have emerged for managing situations where governments can’t or won’t pay their debts (see the prolonged writhings of Greece). Sometimes debts are written off in large part or completely, or the period for repayment is extended well into the future. It boils down to the same thing. Lenders take a hit.
Hence the question: which lenders take which hit? Should other sovereign lenders or perhaps, for example, the IMF do better amidst the carnage than private sector lenders? And as always the mega-question: who decides?
This new case in the New York courts tackles some of these problems head-on.
Back in 2001 Argentina defaulted once again on its sovereign debt and “restructuring” took place. However, two hedge funds (aka ‘vultures’ that speculate on weak states’ sovereign debt problems) have objected to losing out from this process and have taken the issue to court. The judge has ruled in their favour, but more importantly has issued an order stopping third parties from “aiding and abetting” violations of his ruling. This deters banks from making payments to other creditors under the restructuring deal, creating disarray in the wider restructuring process and other Argentinean financial transactions.
Expensive consternation. Could this decision force another Argentinean default in which everyone loses even more? More lawyers pile in and start filing appeals.
How far does this case matter? These days bond agreements typically contain “collective action” clauses that allow a certain majority of bondholders to force ‘holdouts’ (i.e. the hedge funds in this Argentinean case) to sign up to an agreed settlement. So this problem can’t arise.
On the other hand, when governments default, private creditors traditionally have found themselves towards the sad end of the line of creditors. They have tried to hit back by seizing physical assets owned by those governments (ships, aircraft) but usually fail because of “sovereign immunity”.
This New York case opens the way for a fascinating new approach, allowing creditors to go instead after flows of money to those governments. So a lot is at stake (or at least may be) for the way governments deal with private creditors.
Interesting – but unimportant? Don’t all creditors take the likely creditworthiness of borrowers into account and price that into their business strategy and interest rates?
These problems are fascinating because they cast light on how we look at the moral responsibility, and who bears the cost when people behave irresponsibly.
All government comes complete with vast moral hazard. Government asserts to itself the sole right to use force to compel people on its territory to pay money for causes it proclaims worthy (taxes). Plus government then asserts to itself the right not to pay back debts or to keep its promises, all under the banner of sovereign immunity. Governments as lenders barge to the front of the lenders’ queue when other governments default.
This brutish behaviour is impossible to accept for individuals, so why is it OK for the institution purporting to represent the society comprised of those individuals?
Government greed and profligacy are mainly justified on ill-defined utilitarian grounds: for all the problems governments create, we all benefit overall if the state sets rules and maintains order. But very different arguments are also heard, based on ill-defined lofty principles: government is an a priorimoral force for good, especially redistributive good and ‘fairness’.
These rival positions are neatly expressed in two pieces about this Argentinean debt drama. In the first, Felix Salmon at Seeking Alpha looks hard at what is really happening and finds beneath the bluster and thick legal smoke a conventional battle of hard interests.
But then behold Huffington Post UK, where Nick Deardon of Jubilee Debt Campaign sees things very differently:
international debt is governed by a perverse set of laws, developed since the 1970s, which see a nation state as simply another ordinary actor in the ‘market’. A state, with a duty to protect the human rights of millions of citizens, is dealt with in much the same way as any other company or investment fund – worse in that it doesn’t even have the sort of bankruptcy protection afforded to local authorities and individuals.
In spite of all manner of international treaties and UN conventions, the human rights of citizens is not something to take into account when deciding whether a debt should be paid or not. A state’s first duty is not to its people – but the market.
This couldn’t be better demonstrated than in the latest New York judgement, which implies that a law Argentina democratically passed to prevent the President negotiating with vulture funds, is effectively in contravention of their duty to the market.
Of course the market is unable to function without the state – it was the powerful states of the world, including the US and UK who created the laws governing this investor-friendly paradise. That’s why ‘free market’ bandits like Elliott run to the US courts to try to extract their profits from Argentina.
If we want to try to change this, people must force their governments to speak up for their rights over the rights of the markets. That means speaking up for Argentina’s government when they in turn stand up against the vulture funds.
Perverse laws! Those pernicious, apostrophised ‘markets’! The Argentinean state has a duty to protect the human rights of millions of its citizens (Note: pause for hollow laugh), but should cheerily fulfil that duty by borrowing far beyond its means, then cheating millions of other private citizens elsewhere in the world who foolishly trusted Argentina’s word and lent it their savings.
An investor-friendly paradise! A paradise in which governments cheat private investors then hide behind their ‘sovereign’ rights, and make sure that private investors fall to the bottom of the lenders’ line when things go wrong? The Financial Times is tentatively suggesting that this New York decision “may on the margins encourage better behaviour” by defaulting states. Shock! Encouraging better behaviour by greedy states towards private investors? Whatever next?
The very worst thing about this HuffPo UK populist-collectivist lumpen moralising is that it downplays to nothing much the moral value of those states that borrow money and repay it politely and on time. These states are the backbone of the planet’s financial order.
By contrast incompetent states like Argentina massively mess up time and again and then hoot that they are victims of greedy market forces to wriggle out of their obligations. Maybe they are the vultures, preying down the decades on the good will and patience of everyone else?
By Charles Crawford: Contributing Editor to The Commentator. A former British Ambassador in Sarajevo, Belgrade and Warsaw, he is now a private consultant and writer. Visit his website and follow him on Twitter: @charlescrawford
Photo source: http://www.thehindu.com